## Mr George offers an overview of the UK economy
Speech by the Governor of the Bank of England, Mr E A J George, at a dinner host Birmingham City 2000 in Birmingham, England, on 18 May 1999.
Thank you, Mr Chairman. I am delighted to have been invited to speak at this Birmi City 2000 Dinner on the evening before the first ever meeting of the Court of Direct Bank of England at one of our Regional Agencies. We have decided to hold Court mee periodically outside London for two reasons. First, we want to emphasise that we central bank for the whole of the United Kingdom and that we are very sensitive responsibility. Secondly, we want to draw attention to the existence of our twelv regional agencies (and, as we announced on Monday, we will shortly be opening a f agency in Northern Ireland) and to the important role which they play in inform monetary policy process in particular of real-world conditions on the ground in ind commerce in every part of the United Kingdom.
Our Agent here in the West Midlands, John Beverly, is well known to many of you. He be moving on, to the South West, in the autumn to be replaced by another John! John who is at present a Deputy Chief Cashier. I am sure you will quickly get to know hi well - and I am equally sure that he will represent your various views on the conditions here in the region to the Monetary Policy Committee just as objectiv forcefully as John Beverly has done. I'd like to thank John publicly this evening work, on both your and our behalf, over the past three years.
I thought that in my opening remarks I would talk about the state of the economy as about the substantial imbalance between the domestic and the internationally sectors of the economy and the regional impact of that imbalance, and about the dilemma which that poses for monetary policy. I will then happily try to answ questions.
Let me start then with the overall economy. The economy as a whole has grown consis quarter by quarter now for over seven years - at an average annual rate of 3.2% whic above its long-term trend rate. Consumer price inflation has averaged some 2.7% ov period. Employment has risen to a record level; and the rate of unemployment has fa near 30 year low. All of that is very encouraging.
But since the summer of 1996 our effective exchange rate has appreciated by about 1 we have been affected by a global economic slowdown resulting largely from the fi crisis that began in Asia two years ago. As a result our trade balance with the rest has deteriorated - by some 1¼% of total GDP between 1997 and 1998; employment manufacturing has fallen by around 2% since the beginning of last year; and b confidence fell sharply to levels last seen in the depths of recession - until following interest rate cuts in the autumn, albeit to levels which are almost twic those in the Eurozone.
Now you could be forgiven if you thought that all that was me describing the UK econ an audience in Birmingham, England. In fact it is what my counterpart, Alan Gree might well have said if he were addressing his fellow Americans this evening in Birm Alabama, on the 'Goldilocks' economy of the United States! I tease you in this way
the serious point that we are not alone in facing substantial imbalance within an economy is performing reasonably well in overall terms.
In the case of the United Kingdom - and I'm being serious now - the facts are that economy as a whole has grown consistently for 27 consecutive quarters - though I admit t during the last six months it was a 'damned close run thing' - at an average annual ra 2.9%, which is well above its long-term trend rate of around 2¼%. Consumer price inflatio on the Government's target measure - has averaged some 2.8% over this period - or 2.2% measured in terms of the European Harmonised Index of Consumer Prices. Employment has risen to an all-time high; and the rate of unemployment - despite a very small rise ov past couple of months - is still close to a 20 year low. And all of that, too, encouraging.
But, beginning in the autumn of 1996, our effective exchange rate suddenly appreciated, almost 25% a year or so later. To complete the parallel with the US data, our trade ba with the rest of the world deteriorated - by 1¾% of GDP between 1997 and 1998 - business confidence fell back in the Autumn to levels last seen in 1990, and employment i manufacturing has fallen by 3.3% since the beginning of 1998.
Sterling's appreciation - largely against the core European currencies - was difficu explain in terms of relative monetary conditions and appeared to have more to do with mar uncertainty about the prospects for the euro. But, whatever the cause, it seriously compl our task of monetary management by creating a suddenly much harsher business environment for many of the internationally exposed sectors of the economy - including parts of indu but also much of agriculture and some of the services sectors. Domestic demand, on the o hand, was growing strongly, so strongly in fact that we faced the danger of overheating economy as a whole despite the dampening effect of the appreciation on domestic costs a prices and despite the restraining effect on aggregate demand of the prospective worseni the external trade balance. That was the background to the tightening of monetary policy the middle of 1997 designed to moderate the pace of overall demand growth. We were of course well aware of the pressures on the internationally exposed sectors, and we made allowance for the twin effects of the strong exchange rate on the price level and on agg demand in making our projections of future inflation. But if we had held off from tight policy to moderate the pace of the overall expansion at that stage - in order to try to the exposed sectors - the chances were that inflation would have accelerated, and tha would then eventually have had to bring the economy as a whole to an abrupt standstill order to bring inflation back under control. That would not have helped anybody.
By the late summer of last year these conflicting pressures in the economy appeared to beginning to ease. Domestic demand growth was indeed moderating - as it needed to do; an the exaggerated strength of sterling's exchange rate was diminishing as the approach of introduction of the euro appeared to generate increased confidence in the new currency.
But we were all then hit by new shocks to the world economy. Russian default, followed the near collapse of a highly-geared US hedge fund, led to a flight of investment into on most secure and highly liquid assets, threatening not only a new round of financial cri the emerging markets of Asia, Latin America and elsewhere, but also, for the first ti credit crunch in major industrial economies, most notably in the US. Meanwhile the Japan economy remained independently mired in recession.
By the time of the annual IMF meetings in Washington last October the public atmos was close to panic and the media noise was of impending world recession. Bus confidence slumped pretty well everywhere, and so too in this country did con confidence. We were faced in the Monetary Policy Committee with a situation in whi overall economic slowdown which we had been seeking to engineer, in order to pr accelerating inflation, threatened to become an unnecessary economic downturn lik produce an unwanted fall in the rate of inflation to significantly below the Governme inflation target.
At the Trades Union Congress in Blackpool last September I had emphasised that inflation objective was symmetrical, and promised that if overall demand threatene significantly below the supply capacity of the economy, with the risk that we would of the inflation target, then we would be just as vigorous in reducing interest rate demand as we had been in raising them when the risks to inflation were on the upsid the new situation, the Monetary Policy Committee promptly reversed engines to pum demand, cutting rates by 2¼% over the next few months to as low as they have been 1971. (This relatively aggressive response was not incidentally - as is sometimes su a sudden conversion to a more activist philosophy, simply a reflection of the rapid the economic prospect which required a strong response.)
Since last autumn the world financial and economic situation has certainly stabilise impact of the continuing strength of domestic demand in the US economy and of beginnings of export-led recovery in a number of emerging markets, particularly in A world commodity prices, notably the price of oil, have shown signs of strengtheni global imbalance seems likely to persist for some time, with domestic demand grow relatively sluggish in Japan, and in the Eurozone taken as a whole. This imbalance, a significant influence on the international pattern of interest and exchange rates important for the future strength of the world economy that as domestic demand growt US moderates - as it almost certainly will, one way or another - domestic demand gr the other industrial countries accelerates to take up the slack.
Here in the UK both business and consumer confidence have improved since the autumn overall output growth seems set to recover, on the back of accelerating domestic growth, to around its long term trend by about the middle of next year. But we, too, to continue to cope with the imbalance between the domestic and internationally sectors of the economy as a result of continuing relative demand weakness in so overseas markets and of relative price effects resulting from a renewed rise in th rate, which, despite the sharp reduction in interest rates, has strengthened agai since the beginning of this year. These external factors will have a continuing impact on our domestic inflation rate - which is likely to remain close either s inflation target. Overall then, although the prospect is for renewed growth with cont inflation over the next couple of years, the tension between the different sect economy has not for the time being disappeared.
Against the background of that brief description of recent and prospective developmen economy, let me now try to draw out what we can, and what we cannot, hope to ac through monetary policy.
Monetary policy operates on the demand side of the economy, and essentially what we ca hope to do - and what we are aiming to do - is to keep overall demand broadly an continuously in line with the underlying supply-side capacity of the economy to meet t demand. How close we come - on average and over time - to meeting the 2½% inflation target is in effect simply a measure of our success in achieving macro-economic stabili this wider sense.
We cannot directly affect supply-side capacity - the underlying rate of growth that we expect to sustain. But, by operating symmetrically - as we have shown that we do - we c provide an environment in which supply-side improvements (for example, more rapid productivity growth which apparently explains the stronger performance of the US economy in the past few years, but which we have yet to see in this country on anything like th scale) have the best chance of feeding through into faster sustained output growth. And, extent that we are successful in maintaining macro-economic stability, that can hel improve our supply-side performance indirectly by lowering real long-term interest rates encouraging better decision-making in the economy as a whole with less distortion fro unnecessary erratic movements, particularly in nominal values.
But we can only hope to maintain macro-economic stability for the economy as a whole. Wha we cannot hope to do is to provide an equally stable environment for every sector of economy or for every business enterprise, nor therefore can we hope to maintain a sta environment for those regions of the country with heavy concentrations of particular sect businesses.
We cannot hope, for example, nor should we seek, to obstruct structural change. Consume demands change over time, and so, too, do technologies and management and production techniques. Competition, to seek out such changes and to exploit them to meet social ne more efficiently - however unwelcome it may be to establish producers - is a vital driv supply-side improvement, increasing the potentially sustainable growth rate at the ma economic level from which we all stand to benefit.
Nor can we realistically hope to avoid all shorter-term fluctuations associated wit business cycle, for example, or as a result simply of random shocks - though we can aim moderate their impact rather than exaggerate it as we have done at times in the past.
Nor, finally, can we hope to insulate ourselves from shocks originating overseas. That not mean that we do not understand the painful impact of the recent state of the w economy or of the strong exchange rate. Nor does it mean that we simply ignore the pligh the adversely affected sectors. We are concerned - as you are - with the health of every of the economy, we fully appreciate the interdependence of the different sectors, and we understand the part that greater real exchange rate stability can play in promoting balanced economic growth. But the harsh reality is that we could only seek to achiev particular exchange rate in order to protect the internationally exposed sectors at the destabilising the economy as a whole, and there would - as we have recently seen - be assurance even so that we would be successful in achieving and maintaining a particu exchange rate. We do, as I say, take full account of the impact of world demand and of exchange rate on the likely path of inflation, and, to the extent that these influen exerting a disinflationary effect, interest rates are lower than would otherwise be th That was the reality behind the statement made after our last MPC meeting that if
exchange rate does not decline from its present high level, as we assume that it wil line with interest rate differentials, then, depending on other developments in th there might need to be further easing of interest rates to keep inflation on track. today.
But let me be quite clear. This does not mean that we have any particular targe exchange rate. Nor can it mean that we set interest rates simply by reference prevailing elsewhere. It is naïve to complain that our interest rates are twice tho without recognising that we are operating closer to capacity than is the case in the a whole - or that unemployment there is running at twice the rate in this country ev I agree - much of that difference is to be explained by structural, supply-side, rig than simply cyclical divergence.
No-one, Mr Chairman, is more conscious of the limits to what we can hope to achieve t monetary policy than I am. But operating within those limits, we have been able to greater macro-economic stability, reflected in the rate of inflation, than we have generation. And that stability, together with the improved supply-side flexibil economy, has delivered a rate of unemployment in the economy as a whole that, desp recent modest upturn, is still close to the lowest rate we have seen in almost 20 what is true for the UK as a whole is true for most of the individual regions of th That includes the West Midlands, where, on a claimant count basis, unemployment at 4 actually only marginally above the national average and still just about the lowest since 1980.
Macro-economic stability cannot solve all our problems. But it can certainly help, fact the best contribution that monetary policy can make to the sustained growth o high levels of employment, and rising living standards. It helps particularly wher supply-side flexibility and sectoral diversification. Birmingham, and the West Midla generally, have made - and are making - considerable strides in those directions, bu existing strengths certainly but also developing new skills and new activities. B City 2000 has, I know, played an important role in this forward-looking appr congratulate you and encourage you to persist in your endeavours - in conjunction West Midlands Regional Development Agency - well into the next millennium, despite apparently non-Y2K-compliant title.